It’s not unusual for one company to own another company. In this lesson, you’ll learn about wholly owned subsidiaries, including their advantages and disadvantages. You’ll also have a chance to take a short quiz after the lesson.
What Is a Wholly Owned Subsidiary?
A wholly owned subsidiary is a company that is completely owned by another company. The company that owns the subsidiary is called the parent company or holding company. The parent company will hold all of the subsidiary’s common stock. Since the parent company owns all of the subsidiary’s stock, it has the right to appoint the subsidiary’s board of directors, which controls the subsidiary.
Wholly owned subsidiaries may be part of the same industry as the parent company or part of an entirely different industry. Sometimes, a company will spin off part of itself as a wholly owned subsidiary, such as a computer company spinning off its printer manufacturing division.
Advantages of a Wholly Owned Subsidiary
Wholly owned subsidiaries offer some advantages to the parent company. Companies that must rely upon suppliers and service providers can take control of their supply chain by use of wholly owned subsidiaries. This is a means of vertical integration where companies in a supply chain are under the control of a common owner. For example, a car manufacturing company may have several wholly owned subsidiaries, including a tire company and several different auto parts companies.
Wholly owned subsidiaries also offer an opportunity for companies to diversify and manage risk. Diversification is a means for a company to reduce risk by developing different types of businesses so that if one business or industry isn’t doing well, its other businesses may be able to pick up the slack and keep the company profitable. For example, a computer company may decide to get into the printer business, the television business, and the tablet business and either buy or form a wholly owned subsidiary for each new business. Damage from the failure of one subsidiary will not necessarily be fatal to the parent company.
Similarly, a company can reduce its risk in entering into a new market or industry by using subsidiaries which help minimize the parent company’s exposure. For example, if your company wants to enter into an emerging market that hasn’t been established, it can form a subsidiary to enter the market leaving much of the risk of loss on the subsidiary’s shoulders.
A company may also create or purchase wholly owned subsidiaries when conducting business abroad. Sometimes, a parent company will create a subsidiary in a foreign country because it will receive favorable tax treatment from the foreign government. Alternatively, a parent company may be required to form a local subsidiary in order to conduct business in the country. The subsidiary may even have to be formed with a local business partner.
Disadvantages of a Wholly Owned Subsidiary
The use of wholly owned subsidiaries does pose some disadvantages. More taxes may result with use of separate business entities. Use of diversification can have a downside because it may cause the parent company to lose focus on what it does best. This may especially be true if the diversification is not reasonably related to the parent company’s industry or field of expertise, such as a computer company buying a dog food company.
Finally, you should note that the parent company does have a legal duty to promote the corporate interests of its subsidiaries. There may be a conflict of interest between the parent company and its subsidiaries. For example, a car manufacturing company may want below market prices for car parts supplied by its subsidiary, but that is against the subsidiary’s corporate interest.
Let’s review. A wholly owned subsidiary is a company completely owned by another company. The company that owns the subsidiary is called the parent company or holding company. Advantages of using wholly owned subsidiaries include vertical integration of supply chains, diversification, risk management, and favorable tax treatment abroad. Disadvantages include the possibility of multiple taxation, lack of business focus, and conflicting interest between subsidiaries and the parent company.
Vocabulary, Advantages ; Disadvantages
- Wholly owned subsidiary: company owned completely by another company
- Parent/Holding company: owner of subsidiary companies
|Advantages and Disadvantages|
|Vertical integration of supply|
|Favorable taxes abroad|
|Possibility of additional taxes|
|Lack of focus|
|Conflict of interest|
Completing the lesson successfully means that you’re now able to:
- Recognize the meaning of a wholly owned subsidiary
- Compare and contrast the advantages and disadvantages of wholly owned subsidiaries